In 2013 the Victoria & Albert Museum in London staged an interactive exhibition based on Hari Kunzu’s dystopian novella Memory Palace. The exhibition depicted a world in which a great electrical storm has wiped out all recorded knowledge and culture and is ruled is ruled by a warrior elite, named the Thing, who believe all civilisation is sinful. The exhibition included a painting of a ruined London with a rusting Olympic stadium and a broken Shard marooned on an island above a sea of drowned towers.
That may be an appropriate image after the majority of UK voters had voted to leave the European Union. Before the referendum the BlackRock Investment Institute had warned that Brexit offered a lot of risk with little obvious reward.
The fund manager said in a report: “We see an EU exit leading to lower UK growth and investment, and potentially higher unemployment and inflation. Any offsetting benefits look more amorphous and less certain, in our view.”
Brexit could lead to the UK losing the ability to use the EU passport to sell financial services into the EU, if this is not renegotiated during the exit process. BlackRock said: “Brexit would cut into the financial industry’s outsized contributions to the UK economy, tax revenues and trade balance, we believe, and offset apparent fiscal gains from leaving the EU. We could see the EU pushing hard to harmonise standards for financial services and capital markets – to the detriment of a UK financial industry dependent on single market access.”
The report added that financial services paid £66.5bn in taxes, or 11% of government tax receipts in fiscal 2015 according to a PwC report, including employment taxes of £30bn for 1.1 million workers. “Suppose 10% of these workers lost their jobs after a Brexit? This could cost the government up to £3bn in annual employment taxes alone – especially if higher-paid workers bore the brunt, we calculate,” said BlackRock.
Jamie Dimon, chairman and chief executive of JP Morgan, saying the firm has 16,000 employees in the UK and will maintain a large presence in London, Bournemouth and Scotland. However he also warned: “In the months ahead, however, we may need to make changes to our European legal entity structure and the location of some roles.”
Mark Boleat, policy chairman of the City of London Corporation, said in a statement: “There will be no mass exit of banks and financial institutions from the Square Mile. The task now is to respect the will of the British people and secure the best deal we can in the negotiations that will follow this vote.”
Boleat said the general view of the City is that the government should push for the UK to retain access to the single market and that the labour market must be kept flexible. “European nations have provided much of the highly-skilled talent we need to succeed and this level of support given to the British economy must continue,” he added.
The Association for Financial Markets in Europe said in a statement that the decision will significantly affect UK-based financial services firms and their ability to serve their clients and customers across Europe.
“A key priority for AFME will be seeking to minimise any potential damage to capital markets in Europe,” said the statement. “We urge the UK and EU authorities to pay close attention to the need for financial stability in the short run, and negotiators to focus on allowing these markets to continue to operate efficiently in the longer run.”
Deutsche Börse and the London Stock Exchange Group said in a statement that the recommended all-share referendum is not conditional on the outcome of the referendum.
However in March the European Central Bank lost a lawsuit against the UK, which could have forced clearing of large euro transactions to move to the eurozone. Now that the UK is leaving the EU, the ECB may try again to move clearing and settlement of euro deals form the UK – which would remove a lot of the efficiency rationale for the merger.
In a survey by Chatsworth Communications before the referendum 65% of respondents said a Brexit would negatively affect London’s position as the world’s largest foreign exchange trading centre.
Nick Murray-Leslie, chief executive of Chatsworth, said in a statement: “There is no doubt that London’s leading position as a $2.2 trillion hub for FX trading is now under threat. Many will now stand by with bated breath as politicians begin the onerous process from untangling itself from a 40 year trading relationship, and wondering what the future holds.”
Viktor Nossek, director of research at ETF issuer WisdomTree Europe, said in a report: “UK financial services are most at risk of seeing trade barriers being erected.”
He added that portfolio investment flows into UK fixed income and equities in 2015 was £270bn, or 14% of the GDP, levels that are extreme compared to years of relative stability during the period post-dotcom bubble and pre-2008 financial crisis. “It is unlikely that foreign investors will be as enthusiastic to allocate into gilts and FTSE All-Share companies to that degree,” said Nossek.
In asset management the UK has a 50% share of the European market, which is contingent on the ability to do business across the continent, as regulations such as Ucits directive and the Alternative Investment Fund Managers Directive allow distribution across the EU.
“To maintain their Ucits or AIF status, UK-based funds might have to move to a European Economic Area jurisdiction,” said BlackRock. “This would likely be a taxable event for investors – a high price to pay.”
In addition the Ucits and AIFMD regimes are recognised in Asia and Latin America so Brexit would also affect global distribution.
Sean Tuffy, head of regulatory intelligence at Brown Brothers Harriman in Dublin, tweeted this morning that asset managers have two key financial regulation issues. The first whether UK-based managers still be able to use MIFID permissions to sell into EU and whether Ireland and Luxembourg UCITS funds still have unrestricted access to UK investors.
The Investment Association, the trade body for UK financial services, said in a statement: “It is important that we adopt a collective long-term focus on how the UK can preserve the pre-eminence of its financial services sector including our highly successful £5.5 trillion asset management industry – the second largest industry of its kind in the world.”
In order to access the EU, UK financial firms will still have to comply with European legislation. Kay Swinburne, MEP and member of the Economics and Monetary Affairs Committee in the European Parliament, said in a speech in January: “Ask Norway, ask Switzerland, for that matter ask South Africa. If you want to have access to the EU market, you have to comply with EU rules.”
Swinburne gave the example of the US which has spent four years trying to meet EU equivalence standards for central counterparties to clear over-the-counter derivatives. She also emphasised that even if the UK votes for Brexit, the country would still have to implement MiFID II, regulations covering European financial markets, which are due to come into force in January 2018.
The UK Financial Conduct Authority said a statement: “Much financial regulation currently applicable in the UK derives from EU legislation. This regulation will remain applicable until any changes are made, which will be a matter for Government and Parliament.”
The FCA said firms must continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for legislation that is still to come into effect.
Jonathan Herbst, global head of financial services at law firm Norton Rose Fulbright, said in a note that while negotiations take place the UK remains a full member of the EU and EU law applies in full.
“So practical questions for example that we’ve had on that, you know, will MiFID be applied in the UK in Jan 18, answer clearly yes. Will it continue to apply,” he added. “Not entirely clear yet but obviously many of the provisions, not just of MiFID but of the capital requirements regulations and many other sort of directives and regulations actually implement international standards, the G20 in particular and Basle, and I think it’s a fairly good guess that one will look at a regime for financial services which is very similar, if not identical, to what we have now.”
BlackRock had warned that sterling was most vulnerable to Brexit fears as it is the most liquid UK financial asset and sterling has already sunk to a 30-year low.
In addition BlackRock said a Brexit would pressure the UK’s budget and current account deficits, hurting the currency and potentially triggering credit downgrades. This morning ratings agency S&P has already said the UK could owe its triple-A rating.
The fund manager also warned Brexit would also deal a blow to domestically focussed UK equities and more than £200bn was wiped off the UK stock market. Bats Exchange said that by 2:45 pm BST € 90.5bn of stock has traded across Europe in comparison to the average daily notional value traded this month of €45.1bn.
In the fixed income market, MarketAxess observed via its Axess All trade tape on Twitter: “Trade tape is typically approx €1.6bn at 11am. We are now at €2.8bn in credit vol. The market continues to move post #EUREF.”
Mark Carney, the Governor of the Bank of England, said this morning some market and economic volatility can be expected as this process unfolds. He said: “But we are well prepared for this. The Treasury and the Bank of England have engaged in extensive contingency planning and the Bank will not hesitate to take additional measures as required as those markets adjust and the UK economy.”
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